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Three indicators can reveal SME insolvency risk up to four years in advance

Corporate distress: A closer look at the downward spiral of failing SMEs & MidCaps in Europe

Key findings

  • Most insolvencies of European SMEs & MidCaps do not come as a surprise. In fact, they are typically the consequence of an ongoing corporate distress over several years. But which are the leading indicators that allow us to detect corporate distress early enough? Our analysis finds three indicators which can point to corporate distress three to four years before the insolvency.
  • The first and most important indicator is profitability. Four years prior to the insolvency, the average Return on Capital Employed (ROCE) is relatively weak. As corporate distress unfolds the companies‘ profitability further decreases significantly and falls deep into negative territory one year before insolvency.
  • The second indicator that points to corporate distress is the capitalization which tends to decline along with the decline in earnings, albeit at a slower pace. As earnings and capitalization deteriorate, the resulting negative impacts on credit risk clearly affect the deleveraging potential as well.
  • The third leading indicator for corporate distress is the interest coverage, which becomes very weak three years prior to insolvency. In other words, at this early stage, operating profits are already or close to being unable to cover interest expenses.

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